I beleive i read somewhere in the Silmarililon that the Valar were not given the power to create life on their own, that is they could not bring new beings into existence in Middle Earth. This is the reason Morgoth took captured Elves and through long and slow torture and his own magic he bred from them the race of Orcs as he wanted beings to serve him. Yet Aule was able to create the race of Dwarves from stone which was not a living thing but stone, how was this possible? Was this a mistake on Professor Tolkiens part? I realize that after Aule created the Dwarves, Illuvatar appeared to him and questioned him about the Dwarves ad Aule was going to slay them but Illuvatar stayed his hand. Is it possible that the ability to create living things ( Man , Elves ) was a power that the Valar possessed but didn't use so as to avoid the wrath of Illuvatar? I would appreciate any and all responses to this question as it is one that always puzzled me.

Aulë created the dwarves, but could not really give them independent life. He gave them limited mobility, but no volition -- they were like his puppets. Ilúvatar scolded him for his presumption. Then:

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Then Aulë took up a great hammer to smite the Dwarves; and he wept. But Ilúvatar had compassion upon Aulë and his desire, because of his humility; and the Dwarves shrank from the hammer and were afraid, and they bowed down their heads and begged for mercy. And the voice of Ilúvatar said to Aulë: Thy offer I accepted even as it was made. Dost thou not see that these things have now a life of their own, and speak with their own voices? Else they would not have flinched from thy blow, nor from any command of thy will. Then Aulë cast down his hammer and was glad, and he gave thanks to Ilúvatar, saying: May Eru bless my work and amend it!

This is a reflection of the ancient theological debate about human volition and free will: God made us free, which is why we are able to sin. We are not His puppets.

'Thy offer I accepted even as it was made. Dost thou not see that these things have now a life of their own, and speak with their own voices? Else they would not have flinched from thy blow, nor from any command of thy will. The above quote is an good example of the 'outdated' language and structure of the Sil that threw me and many others off at first. I don't know if that's the case with you or not, but I'll elaborate a bit just in case. The above quote fro Eru to Aule concerning his acceptance of the Dwarves is just a fancy way of saying, "Aule, don't destroy your creation, I have given your Dwarves life of their own." Even though Aule created the Dwarves, they would not have had independent wills of their own without Eru's intervention. In reality, Aule is the co-creator along with Eru. Aule provided the hroa, which is the physical body, while Eru provided the fea, the spirit. As three great Jewels they were in form. But not until the End, when Fëanor shall return who perished ere the Sun was made, and sits now in the Halls of Awaiting and comes no more among his kin; not until the Sun passes and the Moon falls, shall it be known of what substance they were made. Like the crystal of diamonds it appeared, and yet was more strong than adamant, so that no violence could mar it or break it within the Kingdom of Arda.

Thanks for replying to my post. it was appreciated. Yet I still wonder where it was written that the Valar had the power to create sentient life from stone. maybe there is no answer and i will have to accept it at face value that that power was given to them by Illuvatar.

As noted, Aüle's creations had no independent volition. We used the term "puppets" but in modern times we might call them robots. I think of "sentient" as having the ability to reason independently. As far as being able to create the puppets/robots, Aüle was amazingly talented. After all, Fëanor, his pupil, was able to make the Silmarils capturing the light of the Trees, which was no mean feat, not to mention the palantiri, and he wasn't even a Vala.

Then the seeds that Yavanna had sown began swiftly to sprout and to burgeon, and there arose a multitude of growing things great and small, mosses and grasses and great ferns, and trees whose tops were crowned with cloud as they were living mountains, but whose feet were wrapped in a green twilight. And beasts came forth and dwelt in the grassy plains, or in the rivers and the lakes, or walked in the shadows of the woods. As yet no flower had bloomed nor any bird had sung, for these things waited still their time in the bosom of Yavanna;...

If she "created" the trees, plants, and animals, how did they get their sentience? The answer turns out to be very similar: she prayed to Eru, who listened:

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And Manwë said: O Kementári, Eru hath spoken, saying: Do then any of the Valar suppose that I did not hear all the Song, even the least sound of the least voice? Behold! When the Children awake, then the thought of Yavanna will awake also, and it will summon spirits from afar, and they will go among the kelvar [animals] and the olvar [plants], and some will dwell therein, and be held in reverence...

So the spirits that animate the Fox and the Ents, for example, come from Eru.